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The very backbone of Elliott Wave analysis comes with the mass psychology that accompanies each and every price structure which reinforces the degree of labeling of where we might be in the larger pattern overall. Presented here is a bullish guideline (see chart below) of these social moods that will help the reader to ascertain where we might be at any given time, and more importantly, to what degree of trend.
Impulsive Waves
1st waves are accompanied by the psychology that ''nothing has changed''. In other words, this counter trend rally is perceived as another selling or shorting opportunity in preparation for the next move down. Technically, simple momentum tools like the Relative Strength Index, or more complex tools like the McClellan Oscillator, will usually breakout of indecision or bottoming formations during this time. These momentum breakouts suggest that the balance of money flow is changing direction in preparation for what the price action will later confirm.
2nd waves are ''reinforcement" waves that seem to confirm the overall feeling of wave 1. In this bullish example, those who suggested that more downside was coming during wave 1 will come back and say ''I told you so''. The other characteristic of 2nd waves is that the level of anxiety will generally be more acute than it was prior to the beginning of wave 1 but now at higher price levels than were seen at the actual price bottom. Because of this, retracements will tend to be deep. Technically, the momentum tools mentioned above in wave 1 would be snapping back to what were their breakout areas that confirmed a possible change in direction in which took place in wave 1. All of this action is in spring board preparation from where 3rd waves begin.
3rd waves are ''wonders to behold'' and for many good reasons. Technically, this is the time where most analysts throw in the towel as price is now confirming what the internals told the analyst during wave 1 which was a change in direction was probable. This is also the time in which extremes in many indicators will show up - something in which I refer to as ''flags'' - which are later used in approximating the termination point of the entire 5 wave pattern sequence structure. In equities, these extremes will be measured in the raw data of both breadth and volume - and the strength or weakness of the indicators that use such information - as well as their relationship to each other. Price pattern wise, one will always be able to identify a third wave because of the fact that price patterns will break out of basic support or resistance areas that were previously controlling the price pattern up until that time. Psychologically, this is when the mind set is that we remember how we all got burned before and that in no way is this the start of a major move higher - also known as climbing the ''wall of worry''. Once the market gets high enough, people start throwing in the towel on their bearish mind set, and this continues to a point when all of the ''willing'' buyers are in the market. 3rd waves are also never the shortest wave in a 5 wave structure, and more times than not, are generally the longest wave in either price, percentage gain, or both, to what will eventually be the larger 5 wave pattern structure sequence overall.
4th waves ''come out of the blue'' just when no one expects them and just when everyone thinks that the market can go nowhere but up. This is usually caused by a news related item that was prevalent during the previous bear market. The psychology of the 4th wave is that those who didn't sell back at wave 2 will now be seemingly justified in sticking with those same convictions. This mentality, along with the momentum in which wave 3 brought, basically sets a floor for this correctional process, and why this structure tends to be shallow in its overall pull back. Technically, fourth waves tend to take out the internal momentum lows made during wave 2 thereby confirming that wave 3 has indeed ended and will not turn into a "wave pattern extension". Once there is a basic resolution to whatever the problem was that led to the halt of the previous advance, this is where wave 5 begins.
5th waves are the most ''euphoric'' of the entire wave structure as both technicians and fundamentalists all come to the conclusion that the worse is now behind us. This is where the media joins the party as well, and thereby causes the ''buy with both hands'' mass psychology that comes with this pattern structure. Because of this, the idea that ''this time it's different'', and that the market can go ''nowhere but up'' becomes the overall mind set and people buy just about anything just to say that they had participated. Technically, the internals diverge with the "flag" extremes seen during wave 3 until all of the willing AND unwilling buyers come into the market at which time the 5 wave price pattern structure terminates.
Corrective Waves
"A" waves are then initially looked upon as profit taking phases - that everything is OK - but the market needs to rest. This is when most buy on the dips, and stock brokers are on the phone saying that this is a ''tremendous buying opportunity'' no matter how the fundamentals look, and the news that accompanied the previous 5 wave structure is used in justifying such mentality. This type of thing goes on until the news gets so bad that many start believing that a bear market is about to resume, which promotes heavy selling, and why the internals make their counter trend extreme "flags" during this time.
"B" waves are sucker plays where the market is not in sync - and usually is news related in one way or the other. In the case of equities, one will see inconsistencies between one index and the other either in price or with breadth and volume statistics that accompany such a move. ''B'' waves can make new price extremes that are higher than the orthodox price termination point of the previous 5 wave structure or only partially retrace the ''A'' wave move based on how much emotion accompanies such a pattern. If something doesn't look right or feel right about a price pattern, it's more than likely a ''B'' wave.
"C" waves correct the inconsistencies or indecisiveness that ''B'' waves bring, and again is usually accompanied by news for the masses to digest. Similar to a 3rd wave structure, it starts slowly in accepting that things are not what they seem to be, and then accelerates to a point when all the willing AND unwilling sellers throw in the towel and give up. Technically, the internals will diverge from those extremes seen in wave ''A'', which then sets the platform for a continuation of what is now a new advancing trend.
Of course, time context is everything when trying to decide to what degree each of the above definitions may apply, but these are the general guidelines I personally use when I look at the markets in trying to determine where we are in the larger pattern context. As you can see, it doesn't really depend on having a vast knowledge of Elliott Wave to at least have a grasp of the methodology itself,and this guideline can be aptly applied in bear markets as well.
